The other shoe drops for 2020 withholding

It’s possible that the draft form and the draft instructions will undergo some tweaks. Second drafts should be released sometime next month. But the IRS advises that you start reprogramming based on those second drafts, because it’s unlikely that it will retreat from this new withholding method, like it did last year.

Clarifications

The draft W-4 is based on five “steps,” only two of which are mandatory. The IRS made some key clarifications in Pub. 15-T:

Step 1: Employees provide their names, addresses, SSNs, filing status, etc. This step is mandatory

Step 2: Employees may account for multiple jobs (either their own or their spouses’) here. Pub. 15-T clarifies that employees who check the box in step 2 will increase their withholding on a pay period basis.

Step 3: Employees who can take advantage of child and dependent care credits may complete this step. Pub. 15-T clarifies that this reduction is an annual reduction in employees’ tax liability for the year.

Step 4, Line 4a and 4b: Employees account for other income, like capital gains, on Line 4a and other deductions on Line 4b. Pub. 15-T clarifies that these are annual adjustments. So you increase the annual amount of wages subject to withholding by the annual amount shown in Line 4a and decrease the annual amount of wages subject to withholding by the annual amount shown in Line 4b.

Step 4c: Employees indicate to you any additional withholding on this line. Currently, employees indicate additional withholding on Line 6. This has always been a pay period calculation and neither of the 2020 drafts change that.

Step 5: Employees sign under penalties of perjury. This step is mandatory.

The new withholding method

The IRS has been adamant that it can’t require everyone to refile their W-4s. But the draft withholding tables make good on its earlier promise that the 2020 tables will be compatible with current withholding methods (i.e., W-4s on which employees indicate withholding allowances) and the new method (i.e., where employees tell you how much to increase or decrease their wages subject to withholding).

How this is done: The IRS eliminates pay period calculations from the percentage method tables. In their place, it’s created Standard Withholding Rate Schedules, which you use for employees who don’t refile their W-4s with you and Higher Withholding Rate Schedules, which you use for employees who do refile and check the box in step 2.

For employees who don’t check the box in step 2 and for employees who don’t refile their W-4s, percentage method withholding should feel familiar. But, what is now one somewhat long step to calculate withholding becomes two steps.

The 2020 draft percentage method tables reflect only annual amounts and employees’ tax status (single, married, etc.). Once the annual withholding amount is derived, you divide by the number of pay periods to get pay period withholding.

It also appears that the IRS will still need to issue an annual withholding allowance amount, even though the personal exemption amount, which doubles as the annual withholding allowance amount, has been suspended through 2025.

So let’s see how withholding works out.

Example No. 1: Harry Holloway doesn’t refile

Harry Holloway has been working for Speedy Manufactures since 2015. He’s single, has only this job and is paid $80,000 a year on a biweekly basis. On his 2015 W-4, he has indicated two withholding allowances. He’s never refiled his W-4 with Speedy.

For 2019, Harry’s withholding looks like this (Speedy uses the 2019 percentage method withholding tables):

  1. Find biweekly equivalent: $80,000 ÷ 26 = $3,076.92
  2. Withholding allowances: $161.50 × 2 = –323.00
  3. Wages subject to withholding: $2,753.92
  4. Withholding per biweekly pay period: $414.48

To compare withholding under the current and new methods, we need to assume that Harry still earns $80,000. Speedy first completes the Employer’s Withholding Worksheet. Note: The amount on Line 2 of the worksheet doesn’t exactly equal $80,000.

Speedy skips Line 1d through 1k, since Harry has never refiled his W-4. Speedy picks up with Line 1L.

As indicated on Line 1o, Harry’s wages subject to the new withholding method are: $2,753.84, which is very close to his current withholding.

Speedy skips down to Line 2c to figure Harry’s withholding, since it is using the percentage method.

Harry’s withholding under the new method is also almost spot on to his current withholding: $414.40.

Example #2: New employee Nancy Gallagher

Speedy hires Nancy Gallagher in January 2020. She is married with two kids and files joint tax returns with her husband. She’s also paid $80,000. Nancy’s husband Christopher earns $100,000 a year.

Speedy must complete Lines 1c through 1k, since Nancy is a new employee who filed the new W-4. Nancy’s biweekly wages that are subject to withholding are $2,592.30

Speedy again completed steps 2c through 2j, since it’s using the percentage method.

Speedy must complete step 3 for Nancy, since she’s indicated on her 2020 W-4 that she’s claiming her two kids as dependents.

Nancy reduces her withholding from $241.69, to $87.84, thanks to her two kids.

Care to comment?

The IRS is taking comments on Pub. 15-T through July 8. This may be your only chance to comment, so email the IRS at: WI.W4.Comments@IRS.gov.